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Term Test 1 Study Guide

Course Code
Jack Carr
Study Guide

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I. Ten Principles of Economics
Business Cycle fluctuations in economic activity, e.g. employment & production
Economics the study of how society manages its scarce resources
Efficiency the property of society getting the most it can from its scarce resources
Equity the property of distributing economic prosperity fairly among the members of
Externality the impact of one persons actions on the well-being of a bystander
Incentive something that induces a person to act
Inflation an increase in the overall level of prices in the economy
Marginal Changes small incremental adjustments to a plan of action
Market Economy an economy that allocates resources through the decentralized decisions
of many firms & households as they interact in markets for goods & services
Market Failure a situation in which a market left on its own fails to allocate resources
Market Power the ability of a single economic actor (or small group of actors) to have a
substantial influence on market prices
Opportunity Cost whatever must be given up to obtain some item
Productivity the quantity of goods & services produced from each hour of a workers time
Property Rights—the ability of an individual to own & exercise control over scarce resources
Rational People people who systematically and purposefully do the best they can to achieve
their objectives
Scarcity the limited nature of societys resources
Ten Principles of Economics
1)People face trade-offs
oMaking decisions requires trading off one goal against another
oClassic trade-off is between guns & butter (national defence vs. consumer
oSociety faces trade off of efficiency vs. equity (size of economic pie vs.
2)The Cost of Something is What You Give Up to Get It

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oComparison of costs & benefits of alternative courses of action
oMust consider the opportunity cost
3)Rational People Think at the Margin
oMarginal changes (small incremental adjustments) to existing plan of action
oDecisions made by comparing marginal benefits & marginal costs
oA persons willingness to pay for any good is based on marginal benefit that
an extra unit will yield
oMarginal benefit depends on how many units a person already has
oA rational decision maker acts if & only if marginal benefit exceeds marginal
4)People Respond to Incentives
oBecause rational ppl make decisions by comparing costs & benefits
oDirect & unintended effects of altering incentives
oAlteration of the cost-benefit calculation
5)Trade Can Make Everyone Better Off
oTrade allows each person to specialize in the activities he/she does best &
enjoy a greater variety of goods & services
oSimultaneously competitors & partners
6) Markets Are Usually a Good Way to Organize Economic Activity
oMarket economy > central planning
oDecisions of a central planner = replaced by decisions of millions of firms
oFirms & households interact in marketplace; prices & self-interest guide

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oFree markets comprised of buyers & sellers primarily interested in own well-
oAdam Smith: Households & firms interact in markets as if guided by an
invisible hand
oMarket prices reflect both value of a good to society & the cost of making that
oSmiths insight: Prices adjust to guide these individuals to reach outcomes
maximize the welfare of society as a whole
oTaxes distort prices, price control causes harm
7)Governments Can Sometimes Improve Market Outcomes
oInvisible Hand can work magic only if govt enforces rules & maintains
oRely on govt-provided services & courts to enforce property rights
oI.H. not omnipotent 2 reasons for govt to intervene in economy & change
allocation of resources
To promote efficiency
To promote equity
oMost policies aim to either enlarge economic pie or change division of
oI.H. may also fail to ensure equitable distribution of economic prosperity
oAlthough govt can improve market outcomes at times doesnt mean will
8)A Countrys Standard of Living Depends on Its Ability to Produce Goods & Services
oLarge variation in avg. Income reflected in various measures of quality of life
oBig changes in living standards over time
oAlmost all variation in living standards is due to differences in countries
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